CHINA MONEY-Central bank and traders briefly see eye-to-eye on yuan

Mon Aug 18, 2014 1:12am EDT

Related Topics

* Spot rate and c.bank guidance rate rarely trade together

* Convergence suggests more mkt-driven fixing by PBOC - strategist

* 200-day MA spot rate and midpoint match for first time since Feb

* Spread between two has remained narrow for 9 days

* Benefits for offshore investors hedging with NDFs - strategist

By Pete Sweeney and Saikat Chatterjee

SHANGHAI/HONG KONG, Aug 18 (Reuters) - China's central bank and currency traders have found rare consensus on the yuan's value after months of widely divergent pricing, but analysts are divided about whether the current accord signifies a genuine relaxation of control by Beijing.

The spot market exchange rate and the central bank's guidance rate, or midpoint, have converged dramatically in recent weeks after spending months on opposite sides of the room. The 200-day moving average of the spot rate and the midpoint matched up exactly on Monday morning at 6.1528 yuan per dollar.

It isn't supposed to be an unusual phenomenon; according to official rhetoric, the midpoint setting is based on a market-driven valuation based on a basket of currencies.

But ever since the central bank began widening the yuan's trading range, giving the spot rate wider room to diverge from the official guidance rate, the midpoint has looked anything like a median market price.

During a long-running rally that began in 2012, for example, the spot rate crossed to the strong side of the midpoint in September, then continued to trade at a premium on every trading day until February 2014.

February was the month when the People's Bank of China (PBOC) engineered a dramatic slide in the yuan, which led to major losses among speculators and Chinese corporates. The spot rate then crossed to the weak side of the band and traded consistently at a discount until August, when it once again touched the midpoint.

But once the spot touched the guidance rate on Aug. 6 on the back of a recovery rally, a curious thing happened: the midpoint appeared to suddenly begin following the spot rate, as if the PBOC had waited for the market to catch up, then began walking alongside. Since then, the two rates have largely moved in tandem, the longest such accord between the guidance rate and the actual market price since September 2012. GRAPHIC: link.reuters.com/req62w

"I think perhaps the PBOC is trying to manage the midpoint in a way that reflects the market, that would be a logical explanation," said Dariusz Kowalczyk, strategist at Credit Agricole CIB in Hong Kong, although he allowed that traders "might not have the guts" to push the spot rate too far above the PBOC's guidance for now.

"But because the correlation has lasted for some time, it's more likely there's a policy effort here to keep the two close together."

Kowalczyk added that the convergence would also benefit the foreign multinationals which hedge their yuan risk using offshore non-deliverable forward (NDF) contracts, which are based and settled according to the midpoint, not the traded rate. That means that when the traded rate and the midpoint are far apart, there can be considerable risk in using NDFs.

FUNNY ARITHMETIC

The PBOC says it refers to a basket of currencies when setting the yuan's daily midpoint fixing rate, but it has left key methodological details vague, giving it wide latitude to set the midpoint where it wants.

This has led to many episodes of anomalous behavior, most notably in late 2013 when the spot rate flatlined against the strong side of the trading band for weeks on end as the PBOC held the midpoint far below market estimates, causing transaction volumes to collapse.

But the midpoint leash has grown very long since.

The PBOC widened the official trading band in March to 2 percent on either side of the midpoint, up from the previous 1 percent. Even fully liberalised currencies rarely move across such a wide range on a given day, so in theory, the wider band is a dramatic reform -- provided the PBOC sets the midpoint in rough accordance with market reality.

Given a history of meddling, however, some remain sceptical, arguing that the PBOC has simply changed policy directions instead of easing its grip.

"The PBOC's actions earlier this year were aimed at showing the market who is the boss," said the head of an Asian macro hedge fund in Hong Kong, who spoke on condition of anonymity.

"We must look at recent gains due to a pick-up in capital inflows from seasonal factors rather than a shift in their currency management policies."

(Editing by Jacqueline Wong)

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